**FORM 10-QSB**

 

**QuarterlyReport Under Section 13 or 15(d) of the Securities Exchange Act of 1934**

** **

**For thequarterly period ended October 31, 2004**

** **

**Commission File No.****1-8125**

 

**TOROTEL, INC.**

(Exact name of small business issuer asspecified in its charter)

 
| **MISSOURI**                                                                        |   | **44-0610086**                       |
|-------------------------------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of  incorporation or organization)                     |   | (I.R.S. Employer Identification No.) |
|                                                                                |   |                                 |
|                                                                                |   |                                 |
| **620 NORTH LINDENWOOD DRIVE, OLATHE, KANSAS  66062**                               |
| (Address of principal executive offices)                                            |
|                                                                                |   |                                 |
| **(913) 747-6111**                                                                  |
| (Issuer’s telephone number)                                                    |
|                                                                                |   |                                 |
| **NONE**                                                                            |
| (Former name, former address and former  fiscal year, if changed since last report) |

 

Check whether the issuer (1) filed all reports required to be filed bySection 13 or 15(d) of the Exchange Act during the past 12 months and (2) hasbeen subject to such filing requirements for the past 90 days.

 

Yes  ý   No  o

 

As of April 8, 2005, there were 5,111,590 shares of Common Stock, $.01Par Value, outstanding.

 

 

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TOROTEL, INC. AND SUBSIDIARIES

 

INDEX

 
| PART I.                                                                                     | FINANCIAL INFORMATION                                           |   |
|---------------------------------------------------------------------------------------------|-----------------------------------------------------------------|--------|
|                                                                                        |                                                            |   |
| Item 1.                                                                                     | Financial Statements                                            |   |
|                                                                                        |                                                            |   |
| Consolidated Balance Sheet as of October  31, 2004                                          |                                                            |
|                                                                                        |                                                            |   |
| Consolidated Statements of Operations for  the six months ended October 31, 2004 and 2003   |                                                            |
|                                                                                        |                                                            |   |
| Consolidated Statements of Operations for  the three months ended October 31, 2004 and 2003 |                                                            |
|                                                                                        |                                                            |   |
| Consolidated Statements of Cash Flows for  the six months ended October 31, 2004 and 2003   |                                                            |
|                                                                                        |                                                            |   |
| Notes to Consolidated Financial Statements                                                  |                                                            |
|                                                                                        |                                                            |   |
| Item 2.                                                                                     | Management’s Discussion and Analysis or  Plan of Operation |   |
|                                                                                        |                                                            |   |
| Item 3.                                                                                     | Controls and Procedures                                         |   |
|                                                                                        |                                                            |   |
| PART II.                                                                                    | OTHER INFORMATION                                               |   |
|                                                                                        |                                                            |   |
| Item 6.                                                                                     | Exhibits and Reports on Form 8-K                                |   |
|                                                                                        |                                                            |   |
| SIGNATURES                                                                                  |                                                            |
|                                                                                             |                                                                 |        |  |  |

 

----

 

PART I.  FINANCIAL INFORMATION

 

Item 1.    Financial Statements

 

CONSOLIDATED BALANCE SHEET (Unaudited)

As of October 31, 2004

 
| ASSETS                                           |   |        |      |
|--------------------------------------------------|--------|-------------|-----------|
|                                             |   |        |      |
| Current assets:                                  |   |        |      |
| Cash                                             |   | $           | 47,000    |   |
| Accounts receivable, net                         |   | 575,000     |      |
| Inventories                                      |   | 401,000     |      |
| Prepaid expenses and other current assets        |   | 31,000      |      |
|                                             |   | 1,054,000   |      |
|                                             |   |        |      |
| Property, plant and equipment, net               |   | 1,070,000   |      |
|                                             |   |        |      |
| Real estate held for sale                        |   | 248,000     |      |
| Intangible assets, net                           |   | 825,000     |      |
| Equity investment                                |   | 74,000      |      |
| Other assets                                     |   | 24,000      |      |
|                                             |   |        |      |
|                                             |   | $           | 3,295,000 |   |
|                                             |   |        |      |
| LIABILITIES AND STOCKHOLDERS’ EQUITY        |   |        |      |
|                                             |   |        |      |
| Current liabilities:                             |   |        |      |
| Current maturities of long-term debt             |   | $           | 54,000    |   |
| Trade accounts payable                           |   | 212,000     |      |
| Accrued liabilities                              |   | 153,000     |      |
| Accrued interest on note payable to shareholders |   | 5,000       |      |
|                                             |   | 424,000     |      |
|                                             |   |        |      |
| Long-term debt, less current maturities          |   | 1,190,000   |      |
|                                             |   |        |      |
| Note payable to shareholders                     |   | 750,000     |      |
|                                             |   |        |      |
| Stockholders’ equity:                       |   |        |      |
| Common stock, at par value                       |   | 52,000      |      |
| Capital in excess of par value                   |   | 12,362,000  |      |
| Accumulated deficit                              |   | (11,278,000 | )         |
|                                             |   | 1,136,000   |      |
| Less treasury stock, at cost                     |   | 205,000     |      |
|                                             |   | 931,000     |      |
|                                             |   |        |      |
|                                             |   | $           | 3,295,000 |   |

 

The accompanying notes are an integral partof this statement.

 

1

----

 

CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

Six Months Ended October 31,

 
| ** **                                         | ** ** | **2004**  | ** ** | **2003**  | ** ** |
|----------------------------------------------------|------------|-----------|------------|-----------|------------|
| Net sales                                          |       | $         | 2,172,000  |      | $          | 2,197,000 |   |
| Cost of goods sold                                 |       | 1,450,000 |       | 1,381,000 |       |
|                                               |       |      |       |      |       |
| Gross profit                                       |       | 722,000   |       | 816,000   |       |
|                                               |       |      |       |      |       |
| Operating expenses:                                |       |      |       |      |       |
| Engineering                                        |       | 102,000   |       | 94,000    |       |
| Selling, general and administrative                |       | 562,000   |       | 491,000   |       |
| Amortization of intangible assets                  |       | 36,000    |       | 77,000    |       |
|                                               |       | 700,000   |       | 662,000   |       |
|                                               |       |      |       |      |       |
| Earnings from operations                           |       | 22,000    |       | 154,000   |       |
|                                               |       |      |       |      |       |
| Other expense (income):                            |       |      |       |      |       |
| Interest expense                                   |       | 69,000    |       | 35,000    |       |
| Equity in loss of investee                         |       | 76,000    |       | 68,000    |       |
|                                               |       | 145,000   |       | 103,000   |       |
|                                               |       |      |       |      |       |
| Earnings (loss) before provision for income  taxes |       | (123,000  | )          | 51,000    |       |
|                                               |       |      |       |      |       |
| Provision for income taxes                         |       | —    |       | —    |       |
|                                               |       |      |       |      |       |
| Net earnings (loss)                                |       | $         | (123,000   | )         | $          | 51,000 |   |
|                                               |       |      |       |      |       |
| Basic and diluted earnings (loss) per share        |       | $         | (.02       | )         | $          | .01 |   |

 

The accompanying notes are an integral partof these statements.

 

2

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CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

Three Months Ended October 31,

 
| ** **                                         | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------------------|------------|----------|------------|----------|------------|
| Net sales                                          |       | $        | 1,168,000  |     | $          | 1,119,000 |   |
| Cost of goods sold                                 |       | 771,000  |       | 706,000  |       |
|                                               |       |     |       |     |       |
| Gross profit                                       |       | 397,000  |       | 413,000  |       |
|                                               |       |     |       |     |       |
| Operating expenses:                                |       |     |       |     |       |
| Engineering                                        |       | 50,000   |       | 49,000   |       |
| Selling, general and administrative                |       | 274,000  |       | 247,000  |       |
| Amortization of intangible assets                  |       | 27,000   |       | 39,000   |       |
|                                               |       | 351,000  |       | 335,000  |       |
|                                               |       |     |       |     |       |
| Earnings from operations                           |       | 46,000   |       | 78,000   |       |
|                                               |       |     |       |     |       |
| Other expense (income):                            |       |     |       |     |       |
| Interest expense                                   |       | 35,000   |       | 18,000   |       |
| Equity in loss of investee                         |       | 48,000   |       | 42,000   |       |
|                                               |       | 83,000   |       | 60,000   |       |
|                                               |       |     |       |     |       |
| Earnings (loss) before provision for income  taxes |       | (37,000  | )          | 18,000   |       |
|                                               |       |     |       |     |       |
| Provision for income taxes                         |       | —   |       | —   |       |
|                                               |       |     |       |     |       |
| Net earnings (loss)                                |       | $        | (37,000    | )        | $          | 18,000 |   |
|                                               |       |     |       |     |       |
| Basic and diluted earnings (loss) per share        |       | $        | —     |     | $          | — |   |

 

The accompanying notes are an integral partof these statements.

 

3

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CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

Six Months Ended October 31,

 
| ** **                                                                                            | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Cash flows from operating activities:                                                                 |       |     |       |     |       |
| Net earnings (loss)                                                                                   |       | $        | (123,000   | )        | $          | 51,000 |   |
| Adjustments to reconcile net earnings  (loss) to net cash provided by (used in) operating activities: |       |     |       |     |       |
| Equity in loss of investee                                                                            |       | 76,000   |       | 68,000   |       |
| Depreciation and amortization                                                                         |       | 68,000   |       | 89,000   |       |
| Increase (decrease) in cash flows from  operations resulting from changes in:                         |       |     |       |     |       |
| Accounts receivable                                                                                   |       | (262,000 | )          | (179,000 | )          |
| Inventories                                                                                           |       | (74,000  | )          | (69,000  | )          |
| Prepaid expenses and other assets                                                                     |       | (10,000  | )          | (36,000  | )          |
| Trade accounts payable                                                                                |       | (147,000 | )          | 33,000   |       |
| Accrued liabilities                                                                                   |       | 35,000   |       | (27,000  | )          |
|                                                                                                  |       |     |       |     |       |
| Net cash provided by (used in) operating  activities                                                  |       | (437,000 | )          | (70,000  | )          |
|                                                                                                  |       |     |       |     |       |
| Cash flows provided by (used in) investing  activities:                                               |       |     |       |     |       |
| Capital expenditures                                                                                  |       | (22,000  | )          | (24,000  | )          |
| Apex investment costs                                                                                 |       | —   |       | (89,000  | )          |
|                                                                                                  |       |     |       |     |       |
| Net cash used in investing activities                                                                 |       | (22,000  | )          | (113,000 | )          |
|                                                                                                  |       |     |       |     |       |
| Cash flows from financing activities:                                                                 |       |     |       |     |       |
| Principal payments on long-term debt                                                                  |       | (26,000  | )          | (27,000  | )          |
|                                                                                                  |       |     |       |     |       |
| Net cash used in financing activities                                                                 |       | (26,000  | )          | (27,000  | )          |
|                                                                                                  |       |     |       |     |       |
| Net increase (decrease) in cash                                                                       |       | (485,000 | )          | (210,000 | )          |
| Cash, beginning of period                                                                             |       | 532,000  |       | 701,000  |       |
|                                                                                                  |       |     |       |     |       |
| Cash, end of period                                                                                   |       | $        | 47,000     |     | $          | 491,000 |   |
|                                                                                                  |       |     |       |     |       |
| Supplemental Disclosures of Cash Flow  Information                                                    |       |     |       |     |       |
| Cash paid during the period for:                                                                      |       |     |       |     |       |
| Interest                                                                                              |       | $        | 69,000     |     | $          | 35,000 |   |
| Income taxes payable                                                                                  |       | $        | —     |     | $          | — |   |

 

The accompanying notes are an integral partof these statements.

 

4

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

Note 1 - Basis of Presentation

 

Torotel specializes in the custom design and manufacture of a widevariety of precision magnetic components, consisting of transformers,inductors, reactors, chokes and toroidal coils, for use in commercial,industrial and military electronics. Torotel also designs and distributes ballast transformers for theairline industry.  Approximately 97% ofTorotel’s sales are derived from domestic customers.  The accompanying unaudited consolidatedfinancial statements reflect the normal recurring adjustments, which are, inthe opinion of management, necessary to present fairly Torotel’s financialposition at October 31, 2004, and the results of operations for the six monthsended October 31, 2004.

The financial statements contained herein should be read in conjunctionwith Torotel’s financial statements and related notes filed on Form 10-KSB forthe year ended April 30, 2004.

 

Note 2 - Inventories

 

The components of inventories are summarized as follows:

 
| Raw materials   |   | $       | 110,000 |   |
|-----------------|--------|---------|---------|--------|
| Work in process |   | 223,000 |    |
| Finished goods  |   | 68,000  |    |
|            |   | $       | 401,000 |   |

 

Note 3 - Income Taxes

 

Torotel has net operating loss carryforwards available as benefits toreduce future income taxes, subject to applicable limitations.  These operating loss carryforwards expire invarious amounts in the years 2007 through 2014.

The difference betweenthe financial and tax bases of assets and liabilities is determined quarterly.  Deferred income taxes and liabilities arecomputed for those differences that have future tax consequences using thecurrently enacted tax laws and rates that apply to the periods in which theyare expected to affect taxable income. Valuation allowances are established, if necessary, to reduce thedeferred tax asset to the amount that will, more likely than not, berealized.  Income tax expense is thecurrent tax payable or refundable for the period plus or minus the net changein the deferred tax assets or liabilities. The following table summarizes the components of the net deferred taxasset:

 
| Net operating loss carryforwards |   | $         | 1,768,000 |   |
|----------------------------------|--------|-----------|-----------|--------|
| Inventory valuation reserve      |   | 188,000   |      |
| Depreciation and amortization    |   | 313,000   |      |
| Disposal of ECH liabilities      |   | 137,000   |      |
| Tax credit carryforwards         |   | 19,000    |      |
| Other                            |   | 18,000    |      |
|                             |   | 2,443,000 |      |
| Less valuation allowance         |   | 2,443,000 |      |
|                             |   | $         | —    |   |

 

5

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Note 4 - Earnings Per Share

 

Statement of Financial Accounting Standards (SFAS) No. 128, *Earnings per Share*, requires dualpresentation of basic and diluted EPS on the face of the statement of earningsregardless of whether basic and diluted EPS are the same; and requires areconciliation of the numerator and denominator used in computing basic anddiluted EPS.  Basic EPS excludes dilutionand is computed by dividing earnings available to common stockholders by theweighted average number of common shares outstanding for the period.  Diluted EPS is computed similarly to fullydiluted EPS pursuant to APB Opinion 15. Diluted EPS reflects the potential dilution that could occur ifsecurities or other contracts to issue common stock were exercised or convertedinto common stock or resulted in the issuance of common stock that then sharedin the earnings of the entity.  Pursuantto SFAS No. 128, the basic and diluted earnings per common share were computedas follows:

 

# **Year-to-DateEPS Calculations**

# ** **

| ** **                                  | ** ** | **2004**  | ** ** | **2003**  | ** ** |
|---------------------------------------------|------------|-----------|------------|-----------|------------|
| Net earnings (loss)                         |       | $         | (123,000   | )         | $          | 51,000 |   |
| Weighted average common shares outstanding  |       | 5,111,590 |       | 5,111,590 |       |
| Incremental shares                          |       | —    |       | 1,104     |       |
|                                        |       |      |       |      |       |
| Basic and diluted earnings (loss) per share |       | $         | (.02       | )         | $          | .01 |   |

 

No incremental shares are included in the 2004 EPS calculations becauseof the net loss incurred in the period.

 

# **QuarterlyEPS Calculations**

# ** **

| ** **                                  | ** ** | **2004**  | ** ** | **2003**  | ** ** |
|---------------------------------------------|------------|-----------|------------|-----------|------------|
| Net earnings (loss)                         |       | $         | (37,000    | )         | $          | 18,000 |   |
| Weighted average common shares outstanding  |       | 5,111,590 |       | 5,111,590 |       |
| Incremental shares                          |       | —    |       | 1,757     |       |
|                                        |       |      |       |      |       |
| Basic and diluted earnings (loss) per share |       | $         | —     |      | $          | — |   |

 

No incremental shares are included in the 2004 EPS calculations becauseof the net loss incurred in the period.

 

Note 5 - Employee Stock Options

 

In accordance with the Incentive Compensation Plan approved byshareholders in 1994, Torotel reserved 400,000 common shares for issuance tokey employees pursuant to the exercise of incentive and non-qualified stockoptions granted prior to June 20, 2004. The options are accounted for under APB Opinion 25, *Accounting for Stock Issued to Employees*,and related interpretations.  Theincentive stock options have a term of five years when issued and vest 50% peryear at the end of each of the first two years. The non-qualified stock options have a term of ten years when issued andvest 25% per year at the end of each of the first four years.  The exercise price of each option equals themarket price of Torotel’s common stock on the date of grant.  Accordingly, no compensation cost has beenrecognized for the Plan.

 

Had compensation cost for the Plan been determined based on the fairvalue of the options at the grant dates consistent with the method of Statementof Financial Accounting Standards No. 123, *Accountingfor*

 

6

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*Stock-Based Compensation,*Torotel’soperating results would have been reduced to the pro forma amounts indicatedbelow.

 

# **Year-to-Date**

# ** **

| ** **                                  | ** **  | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------|-------------|------------|----------|------------|----------|------------|
| Net earnings (loss)                         | As Reported |       | $        | (123,000   | )        | $          | 51,000 |   |
|                                        | Pro Forma   |       | $        | (123,000   | )        | $          | 47,000 |   |
|                                        |        |       |     |       |     |       |
| Basic and diluted earnings (loss) per share | As Reported |       | $        | (.02       | )        | $          | .01 |   |
|                                        | Pro Forma   |       | $        | (.02       | )        | $          | .01 |   |

# ** **

# **Quarterly**

 
| ** **                                  | ** **  | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------|-------------|------------|----------|------------|----------|------------|
| Net earnings (loss)                         | As Reported |       | $        | (37,000    | )        | $          | 18,000 |   |
|                                        | Pro Forma   |       | $        | (37,000    | )        | $          | 18,000 |   |
|                                        |        |       |     |       |     |       |
| Basic and diluted earnings (loss) per share | As Reported |       | $        | —     |     | $          | — |   |
|                                        | Pro Forma   |       | $        | —     |     | $          | — |   |

 

The fair value of the incentive stock options granted was estimated onthe date of grant using the Black-Scholes options-pricing model.  The fair value of the options was determinedusing the following weighted average assumptions: no dividend payments over thelife of the options; expected volatility of 551.0%; risk-free interest rate of3.50%; and expected life of five years.

Stock option transactions under the 1994 Incentive Compensation Planfor each period are summarized as follows:

 
| ** **                                                      | ** ** | **2004**                            | ** ** | **2003**                     | ** ** |
|-----------------------------------------------------------------|------------|-------------------------------------|------------|------------------------------|------------|
| ** **                                                      | ** ** | **Weighted  Shares  Under  Option** | ** ** | **Average  Exercise  Price** | ** ** | **Weighted  Shares  Under  Option** | ** ** | **Average  Exercise  Price** | ** ** |
| Outstanding at beginning of period                              |       | 40,000                              |       | $                            | .37        |   | 40,000 |   | $ | .37 |   |
| Granted                                                         |       | —                              |       | —                       |       | — |   | — |   |
| Exercised                                                       |       | —                              |       | —                       |       | — |   | — |   |
| Forfeited                                                       |       | —                              |       | —                       |       | — |   | — |   |
| Outstanding at end of period                                    |       | 40,000                              |       | $                            | .37        |   | 40,000 |   | $ | .37 |   |
|                                                            |       |                                |       |                         |       |   |   |   |   |
| Options exercisable at end of period                            |       | 40,000                              |       | $                            | .37        |   | 40,000 |   | $ | .37 |   |
| Weighted average fair value of options  granted during the year |       |                                |       | —                       |       |   |   | — |   |

 

The following information applies to options outstanding at October 31,2004:

 
| Number outstanding                          |   | 40,000    |   |
|---------------------------------------------|--------|-----------|--------|
| Range of exercise prices                    |   | $         | .37    |   |
| Weighted average exercise price             |   | $         | .37    |   |
| Weighted average remaining contractual life |   | 2.00 yrs. |   |

 

7

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Note 6 - Stock Warrants

 

A warrant certificate issued in May 1998 to purchase 100,000 shares ofTorotel, Inc. common stock at 75 cents per share expired on May 4, 2003.  Stock warrant transactions for each periodare summarized as follows:

 
| ** **                                                       | ** ** | **2004**                            | ** ** | **2003**                     | ** ** |
|------------------------------------------------------------------|------------|-------------------------------------|------------|------------------------------|------------|
| ** **                                                       | ** ** | **Weighted  Shares  Under  Option** | ** ** | **Average  Exercise  Price** | ** ** | **Weighted  Shares  Under  Option** | ** ** | **Average  Exercise  Price** | ** ** |
| Outstanding at beginning of period                               |       | —                              |       | —                       |       | 100,000 |   | $ | .75 |   |
| Granted                                                          |       | —                              |       | —                       |       | — |   | — |   |
| Exercised                                                        |       | —                              |       | —                       |       | — |   | — |   |
| Forfeited                                                        |       | —                              |       | —                       |       | (100,000 | ) | $ | .75 |   |
| Outstanding at end of period                                     |       | —                              |       | —                       |       | — |   | — |   |
|                                                             |       |                                |       |                         |       |   |   |   |   |
| Warrants exercisable at end of period                            |       | —                              |       | —                       |       | — |   | — |   |
| Weighted average fair value of warrants  granted during the year |       |                                |       | —                       |       |   |   | — |   |

 

Note 7 - Amortization ofIntangibles

 

The following tableprovides the gross carrying value and accumulated amortization for each majorclass of intangible asset based on Torotel’s reassessment of previouslyrecognized intangible assets and their remaining amortization lives inaccordance with the adoption of Statement of Financial Accounting Standards No.142, *Goodwill and Other Intangible Assets*:

 
| ** **          | ** ** | ** **                     | ** ** | **2004**                    | ** ** | **2003**                      | ** ** |
|---------------------|------------|--------------------------------|------------|-----------------------------|------------|-------------------------------|------------|
| ** **          | ** ** | **Average  Amortizable  Life** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
| Order backlog       |       | 1                              |       | $                           | 205,000    |                          | $          | 205,000 |   | $ | 205,000 |   | $ | 205,000 |   |
| Aircraft - ballasts |       | 3                              |       | 1,148,000                   |       | 323,000                       |       | 2,177,000 |   | 172,000 |   |
|                |       |                           |       | $                           | 1,353,000  |                          | $          | 528,000 |   | $ | 2,382,000 |   | $ | 377,000 |   |

 

The total intangible amortization expense for the six months endedOctober 31, 2004, was $36,000.  Theestimated aggregate amortization expense for each of the next five years is asfollows:

 

| **April 30,** | ** ** | **Amount** | ** ** |
|---------------|------------|------------|------------|
| 2005          |       | $          | 91,000     |   |
| 2006          |       | 63,000     |       |
| 2007          |       | 42,000     |       |
| 2008          |       | —     |       |
| 2009          |       | —     |       |
|          |       |       |       |
|          |       | $          | 196,000    |   |

 

The carrying value ofthe intangible assets is supported by the estimated amount recoverable from theselling shareholders of Electronika (the Caloyeras Family Partnership).  The selling shareholders contractually guaranteedthat the aggregate sales from Electronika’s existing ballast designs over thefirst five (5) full fiscal years, specifically fiscal years 2003-2007, would beat least $2,500,000, which based on the terms of the 

 

8

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Manufacturing Agreementwith Magnetika, Inc., would result in an aggregate gross profit of $1,500,000before any operating expenses.  Aggregatesales since fiscal 2003 have been $987,000.

 

Note 8 - EquityInvestment

 

Torotel owns 4,355,637common shares (16.47%) of Apex Innovations, Inc. (“Apex”).  These shares were purchased at a cost of 25cents per share.  This investment isaccounted for using the equity method. Because of Apex’s operating losses since inception, and the projectedlosses in the near term, Torotel reduced the carrying value of this investmentat the end of fiscal 2004.

The accompanyingconsolidated statements of operations include a loss of $48,000 and $42,000 forthe six months ended October 31, 2004 and 2003, respectively, which result fromTorotel’s proportionate share of Apex’s operating results for the six monthsended August 31, 2004 and 2003. Condensed financial statements for Torotel’s investment in Apex are asfollows:

 

CondensedBalance Sheet

 
| ** **                | ** ** | **August 31,  2004** | ** ** |
|---------------------------|------------|----------------------|------------|
| Current assets            |       | $                    | 717,000    |   |
| Other assets              |       | 6,662,000            |       |
|                      |       | $                    | 7,379,000  |   |
|                      |       |                 |       |
| Current liabilities       |       | $                    | 1,537,000  |   |
| Other liabilities         |       | 3,420,000            |       |
| Stockholders’ equity |       | 2,422,000            |       |
|                      |       | $                    | 7,379,000  |   |

 

CondensedStatements of Operations

 
| ** **   | ** ** | **6-Mos. Ended  August 31,  2004** | ** ** | **6-Mos. Ended  August 31,  2003** | ** ** | **3-Mos. Ended  August 31,  2004** | ** ** | **3-Mos Ended  August 31,  2003** | ** ** |
|--------------|------------|------------------------------------|------------|------------------------------------|------------|------------------------------------|------------|-----------------------------------|------------|
| Net sales    |       | $                                  | 1,422,000  |                               | $          | 2,485,000                          |       | $                                 | 591,000    |   | $ | 1,142,000 |   |
| Gross profit |       | $                                  | 1,045,000  |                               | $          | 1,022,000                          |       | $                                 | 467,000    |   | $ | 459,000 |   |
| Net loss     |       | $                                  | (460,000   | )                                  | $          | (383,000                           | )          | $                                 | (288,000   | ) | $ | (239,000 | ) |

 

Note 9 – StockAppreciation Rights (SARs)

 

OnSeptember 10, 2004, the board of directors of Torotel approved the DirectorsStock Appreciation Rights Plan (the “Plan”) for non-employee directors.  Each SAR is equal to one share of commonstock of Torotel, and the aggregate number of SARs which may be granted underthe Plan shall not exceed 500,000.

 

Theeffective date of the Plan is October 1, 2004. The SARs are accounted for under Statement of Financial AccountingStandards No. 123, *Accounting forStock-Based Compensation.*

Pursuant to the Plan, 20,000 SARs were granted on the effective date toeach of the three current non-employee directors.  The initial price at which each SAR wasgranted was $.35, which equals the market 

 

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price of Torotel’s common stock on the date of grant.  Accordingly, no compensation cost wasrecognized at the time of grant, but compensation costs will be recognized infuture periods in which the market price of Torotel’s common stock increasesabove the grant price.

SARs shall automaticallybe granted in the future as follows: (1) each person who is elected as adirector, who was not a director on the effective date of the Plan, shall begranted 10,000 SARs on the date such person is elected a director; and (2) oneach May 1 following the effective date during the term of the Plan, eachperson serving as a director on such date shall be granted 10,000 SARs.    After the initial grant, the price at whicheach SAR is granted shall be the average of the closing price of Torotel’scommon stock for the ten consecutive days immediately preceding the date ofgrant.  Upon exercise of a SAR, Torotelwill pay the grantee an amount (the “Spread”) equal to the excess of theExercise Price over the SAR grant price multiplied by the number of sharesbeing exercised.  The Exercise Priceshall be the average of the closing price of Torotel’s common stock for the tenconsecutive days immediately preceding the notice of exercise.  For any payments that exceed $10,000, Torotelhas the option to make quarterly payments over three years with interestpayable quarterly at the prime rate of Torotel’s primary bank.

 

SARs transactions for each period aresummarized as follows:

 
| ** **                                                   | ** ** | **2004**                          | ** ** | **2003**                  | ** ** |
|--------------------------------------------------------------|------------|-----------------------------------|------------|---------------------------|------------|
| ** **                                                   | ** ** | **Weighted  SARs  Under  Option** | ** ** | **Average  Grant  Price** | ** ** | **Weighted  SARs  Under  Option** | ** ** | **Average  Grant  Price** | ** ** |
| Outstanding at beginning of period                           |       | —                            |       | —                    |       | — |   | — |   |
| Granted                                                      |       | 60,000                            |       | $                         | .35        |   | — |   | — |   |
| Exercised                                                    |       | —                            |       | —                    |       | — |   | — |   |
| Forfeited                                                    |       | —                            |       | —                    |       | — |   | — |   |
| Outstanding at end of period                                 |       | 60,000                            |       | $                         | .35        |   | — |   | — |   |
|                                                         |       |                              |       |                      |       |   |   |   |   |
| SARs exercisable at end of period                            |       | —                            |       | —                    |       | — |   | — |   |
| Weighted average fair value of SARs granted  during the year |       |                              |       | —                    |       |   |   | — |   |

 

The following information applies to SARs outstanding at October 31,2004:

 
| Number outstanding                          |   | 60,000    |   |
|---------------------------------------------|--------|-----------|--------|
| Range of grant prices                       |   | $         | .35    |   |
| Weighted average grant price                |   | $         | .35    |   |
| Weighted average remaining contractual life |   | 9.92 yrs. |   |

 

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Item 2.    Management’s Discussionand Analysis or Plan of Operation

 

Overview

 

Torotel, Inc. (“Torotel”)conducts business primarily through two wholly owned subsidiaries, TorotelProducts, Inc. (“Torotel Products”) and Electronika, Inc. (“Electronika”).  In addition, Torotel has a 16.47% equityinterest in Apex Innovations, Inc. (“Apex”).

Torotel Products designsand manufactures a wide variety of magnetic components for use in military,aerospace and industrial electronic applications.  These magnetic components, which consist oftransformers, inductors, reactors, chokes, and toroidal coils, are used tomodify and control electrical voltages and currents in electronic devices.  For example, if equipment containing one ofthese components receives an electrical voltage or current which is too highfor proper operation of the equipment, the component would modify and controlthe electrical voltage or current to allow proper operation of theequipment.  While Torotel Productsprimarily manufactures the components in accordance with pre-developedmechanical and electrical requirements, in some cases it will be responsiblefor both the overall design and manufacture of the components.  The magnetic components are sold tomanufacturers who incorporate them into an end product.  The major applications include aircraftnavigational equipment, voice and data secure communications, medicalequipment, avionics equipment, and conventional missile guidance systems.  Torotel Products markets its componentsprimarily through a direct sales force and one independent manufacturers’representative paid on a commission basis. In addition, Torotel Products is an approved source on numerousapplications, and generally is automatically solicited for any procurementneeds for such applications.  Themagnetic components manufactured by Torotel Products are sold primarily in theUnited States, and most sales are awarded on a competitive bid basis.  The markets in which Torotel Productscompetes are highly competitive.  Asubstantial number of companies sell components of the type manufactured andsold by Torotel Products.  In addition,Torotel Products sells to a number of customers who have the capability ofmanufacturing their own electronic components. The ability of Torotel Products to compete depends, among other things,upon its on-time delivery performance, customized product engineering andtechnical support, marketing capabilities, quality assurance and manufacturingefficiency.  While magnetic componentsare not susceptible to rapid technological change, Torotel Products’ marketshare is susceptible to decline given the highly competitive nature of themarket.

Electronika is amarketing and licensing company selling ballast transformers to the airlineindustry.  These transformers activateand control the lights in commercial airplane cockpits.  Electronika’s ballast transformers areapproved as spare and replacement parts in DC-8, DC-9, DC-10, MD-80, and MD-88aircraft.  However, sales of ballasttransformers have been made primarily for use in DC-8 and DC-9 aircraft.  As a result, the business of Electronika issubject to various risks including, without limitation, any decline in use ofthe referenced aircraft, and competition for the available spare partsbusiness.  Electronika’s sales do notrepresent a significant portion of any particular market.  Electronika’s requirements for the ballasttransformers are outsourced pursuant to a Manufacturing Agreement withMagnetika, Inc. (“Magnetika”), a corporation owned by Peter B. Caloyeras andhis family.  Under the terms of theagreement, Magnetika provides all necessary raw material, labor, testing,packaging and related services required to complete the manufacture, deliveryand sale of the ballast transformers. Electronika retains ownership of all designs, drawings, specificationsand intellectual property rights associated with the ballast transformers.

 

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Torotel’s management is not involved in the daily operations of Apex.  Dale H. Sizemore, Jr., Torotel’s chairman and chief executive officer, served as a member of Apex’s board of directors from March 2002 until his resignation in October 2004.  ***i***-**INFO** is Apex’s umbrella term for a foundational system architecture of patented information management software products created by Apex primarily for government entities.  The success of Apex depends, among other things, its ability to market its products to government entities.  Because of Apex’s operating losses since inception, and the projected losses in the near term, Torotel reduced the carrying value of this investment at the end of fiscal 2004.

 

Business Outlook

 

The industry mix of fiscal 2005 year-to-date sales is 52% defense, 33% aerospace and 15% commercial/industrial.  This mix should continue through the balance of the fiscal year.  The rate of new order bookings did decline in the second quarter, but this decrease should be only temporary as additional military contracts are expected.  Torotel’s aerospace markets, specifically the components used in retrofitting and upgrading instrumentation and communication systems in existing aircraft, remain soft but are expected to improve in the near future based on feedback from customers.  The primary factors that drive gross profit and net earnings for Torotel Products are sales volume and product mix.  The gross profits on mature products/programs and larger transformer devices tend to be higher than those that are still in the prototyping or early production stages and simpler inductor devices.  As a result, in any given accounting period the mix of product shipments between higher and lower margin jobs has a significant impact on the gross profit and net earnings of Torotel Products.  Electronika’s net sales continue to be impacted by the soft conditions in the aerospace market and the decline in the number of active DC-8 and DC-9 aircraft.

 

Results of Operations

 

The following management comments regarding Torotel’s results ofoperations and outlook should be read in conjunction with the ConsolidatedFinancial Statements included pursuant to Item 1 of this Quarterly Report.

The discussion and analysis of the results of operations include theoperations of Torotel, Inc. and its subsidiaries, Torotel Products, Inc. andElectronika, Inc.  While each company’sresults are included in the following discussion, segment reporting is notapplicable because the products offered are similar in form and function, andtarget similar markets.

 

Six Months Ended October 31,2004 Compared With Six Months Ended October 31, 2003

 

Net sales decreased 1%.  The net sales of Torotel Products increased 2% from $2,062,000 to $2,100,000.  This increase is attributable to higher demand from Torotel’s military markets.  The net sales of Electronika decreased 47% from $135,000 to $72,000.  While Electronika’s sales have been impacted by the soft conditions in the aerospace market, the bigger impact going forward will be the decline in the number of active DC-8 and DC-9 aircraft.

Grossprofit as a percentage of net sales decreased 4%.  The gross profit percentage of TorotelProducts decreased nearly 8% primarily because of higher labor costs associatedwith overtime and inefficiencies encountered with the training of newproduction personnel in the winding area. Electronika’s

 

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gross profit as apercentage of net sales increased 60% because of the labor and overhead savingsassociated with the discontinued assembly operation of Electronika-Kansas.

Engineeringexpenses, applicable only to Torotel Products, increased nearly 9% from $94,000to $102,000 because of higher payroll costs associated with more hours workedby part-time personnel and higher travel and training costs.  Management does anticipate an increase in thepresent level of engineering expenses, as the plan is to hire an additionalengineer.

Selling,general and administrative (SG&A) expenses increased 14%.  The SG&A expenses of Torotel, Inc.decreased 49% from $141,000 to $72,000 primarily because of transferring theCEO’s payroll costs of $55,000 to Torotel Products and a $14,000 decrease inprinting costs due to the delay in processing the 2004 annual report toshareholders and proxy materials.  TheSG&A expenses of Torotel Products increased 44% from $329,000 to $474,000primarily because of transferring the CEO’s payroll costs of $55,000 fromTorotel, Inc., a $37,000 increase in payroll costs for an inside salesassociate and clerical help, a $17,000 increase in depreciation, a $13,000increase in utilities costs, an $11,000 increase in training costs, an $11,000increase in property taxes, a $7,000 increase in property and casualtyinsurance costs, and a $6,000 increase building maintenance and repairs.  These increases were offset partially by an$8,000 decrease in professional fees and a $4,000 decrease in payroll servicecosts.  The SG&A expenses ofElectronika decreased 24% from $21,000 to $16,000 because of administrativecosts savings associated with the discontinued assembly operation ofElectronika-Kansas.  Management does not anticipateany significant increase in the present level of SG&A expenses.

Amortizationcosts, entirely attributable to Electronika, decreased 53% from $77,000 to$36,000 (see Note 7 of Notes to Consolidated Financial Statements).

Interestexpense increased 97%.  The interestexpense of Torotel, Inc. decreased from $27,000 to $26,000.  The interest expense of Torotel Productsincreased from $8,000 to $43,000 because of a higher debt balance associatedwith the building purchase in March 2004.

Equityin loss of investee was $76,000 compared with $68,000 in the prior year (seeNote 8 of Notes to Consolidated Financial Statements).

Forthe reasons discussed above, the consolidated pretax earnings decreased from aprofit of $51,000 to a loss of $123,000. The pretax loss of Torotel, Inc. decreased from $236,000 to$174,000.  The pretax earnings of TorotelProducts decreased from $391,000 to $60,000. The pretax loss of Electronika decreased from $104,000 to $9,000.

 

ThreeMonths Ended October 31, 2004 Compared With Three Months Ended October 31, 2003

 

Netsales increased 4%.  The net sales ofTorotel Products increased 6% from $1,048,000 to $1,114,000 because of higherdemand from military markets.  The netsales of Electronika decreased 24% from $71,000 to $54,000 primarily because ofthe decline in the number of active DC-8 and DC-9 aircraft.

Gross profit as a percentage of net sales decreased 3%.  The gross profit percentage of TorotelProducts decreased 7% primarily because of higher labor costs associated withovertime and inefficiencies encountered with the training of new productionpersonnel in the winding area. Electronika’s gross profit as a percentage of net sales increased 60%because of the labor and overhead savings associated with the discontinued assemblyoperation of Electronika-Kansas.

Engineeringexpenses, applicable only to Torotel Products, increased slightly from $49,000to $50,000.  Management does anticipatean increase in the present level of engineering expenses, as the plan is tohire an additional engineer.

 

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Selling,general and administrative (SG&A) expenses increased 11%.  The SG&A expenses of Torotel,Inc.decreased 59% from $81,000 to $33,000 primarily because of transferring the CEO’spayroll costs of $27,000 to Torotel Products, a $16,000 decrease in printingcosts due to the delay in processing the 2004 annual report to shareholders andproxy materials, a $2,000 decrease in directors fees, and a $1,000 decreaseeach in investor relations costs, liability insurance, and professionalfees.  The SG&A expenses of TorotelProducts increased 51% from $155,000 to $234,000 primarily because oftransferring the CEO’s payroll costs of $27,000 from Torotel, Inc., a $19,000increase in payroll costs for an inside sales associate and clerical help, an$8,000 increase in depreciation costs, a $6,000 increase in utilities costs, a$6,000 increase in property taxes, a $5,000 increase in repair and maintenancecosts, a $3,000 increase in property and casualty insurance costs, a $2,000increase in travel costs, a $2,000 increase in equipment rentals, and a $1,000increase in bank charges.  The SG&Aexpenses of Electronika decreased 27% from $11,000 to $8,000 because ofadministrative costs savings associated with the discontinued assemblyoperation of Electronika-Kansas. Management does not anticipate any significant increase in the presentlevel of SG&A expenses.

Amortizationcosts, entirely attributable to Electronika, decreased  31% from $39,000 to $27,000 (see Note 7 ofNotes to Consolidated Financial Statements).

Interestexpense increased 94%.  The interestexpense of Torotel, Inc. decreased slightly from $14,000 to $13,000.  The interest expense of Torotel Productsincreased from $4,000 to $22,000 because of a higher debt balance associatedwith the building purchase in March 2004.

Equityin loss of investee was $48,000 compared with $42,000 (see Note 8 of Notes toConsolidated Financial Statements).

Forthe reasons discussed above, the consolidated pretax earnings decreased from aprofit of $18,000 to a loss of $37,000. The pretax loss of Torotel, Inc. decreased from $137,000 to$94,000.  The pretax earnings of Torotel Productsdecreased from $212,000 to $60,000.  Thepretax loss of Electronika decreased from $57,000 to $3,000.

 

Liquidity and Capital Resources

 

The table below presents the summary of cash flow for the six-month periods indicated.

 
| ** **                            | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------|------------|----------|------------|----------|------------|
| Net cash used in operating activities |       | $        | (437,000   | )        | $          | (70,000 | ) |
| Net cash used in investing activities |       | $        | (22,000    | )        | $          | (113,000 | ) |
| Net cash used in financing activities |       | $        | (26,000    | )        | $          | (27,000 | ) |

 

Net cash used in operating activities fluctuates between periodsprimarily as a result of differences in operating earnings, the timing ofshipments and the collection of accounts receivable, changes in inventory,level of sales and payment of accounts payable. The decrease in net cash used in investing activities is primarilybecause of the additional $89,000 investment made in Apex in 2003.  Capital expenditures were$22,000during the first half of fiscal 2005. Management anticipates approximately $18,000 in capitalexpenditures during the balance of fiscal 2005. Net cash used in financing activities is because of payments onlong-term debt.  Management believes thatthe projected cash flow generated from operations, combined with its existingcash balances, will be sufficient to meet its funding requirements for theforeseeable future.  Torotel does have a$200,000 bank line of credit available, which could be utilized, if required,to help fund growth.

Management believes that inflation will have only a minimal effect onfuture operations since such effects will be offset by sales price increases,which are not expected to have a significant effect upon demand*.*

 

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Forward-Looking Information

 

Thisreport, as well as our other reports filed with the Securities and ExchangeCommission (“SEC”), and in press releases and other public communications throughoutthe year, contains forward-looking statements made pursuant to the safe harborprovisions of The Private Securities Litigation Reform Act of 1995.  Forward-looking statements include allinformation on our expected financial position, results of operations, cashflows, strategy, budgets and management’s plans and objectives.  These forward-looking statements are based onassumptions about a number of important factors and involve risks anduncertainties that could cause actual results to be different from what appearhere.  These risk factors include:impairment of intangible assets and other investments, decreased demand forproducts, delays in developing new products, expected orders that do not occur,loss of key customers, the impact of competition and price erosion as well assupply and manufacturing constraints, issues involved in relocatingmanufacturing operations, and other risks and uncertainties.  In light of these risks and uncertainties,there can be no assurance that the forward-looking information contained inthis report will prove accurate, and our actual results may differ materiallyfrom these forward-looking statements.

 

Item 3.    Controls and Procedures

 

Torotel’s Chief Executive Officer and Chief Financial Officer(collectively, the “Certifying Officers”) are responsible for establishing andmaintaining disclosure controls and procedures. Such officers have concluded (based upon their evaluation of thesecontrols and procedures as of a date within 90 days of the filing of this report)that Torotel’s disclosure controls and procedures are effective to ensure thatinformation required to be disclosed in this report is accumulated andcommunicated to Torotel’s management, including its principal executiveofficers as appropriate, to allow timely decisions regarding requireddisclosure.  The Certifying Officers alsohave indicated that there were no changes in Torotel’s internal controls duringthe reporting period.

 

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PART II.      OTHER INFORMATION

 

Item6.   Exhibits and Reports on Form 8-K

 

a)                          Exhibits

 
| Exhibit 10.4 |   | Directors Stock Appreciation Rights Plan                                                                                |
|--------------|--------|-------------------------------------------------------------------------------------------------------------------------|
| Exhibit 31.1 |   | Officer Certification                                                                                                   |
| Exhibit 31.2 |   | Officer Certification                                                                                                   |
| Exhibit 32.1 |   | Certification Pursuant to 18 U.S.C. Section  1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| Exhibit 32.2 |   | Certification Pursuant to 18 U.S.C. Section  1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |

 

b)                   Reports on Form8-K       There were no reports filed onForm 8-K during the three months ended October 31, 2004.

 

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SIGNATURES

 

In accordance with the requirements of the Securities Exchange Act of1934, the Registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 

 
| Torotel, Inc.             |   |
|---------------------------|--------|
| (Registrant)              |   |
|                      |   |
|                      |   |
| /s/ Dale H. Sizemore, Jr. |   |   |
| Dale H. Sizemore, Jr.     |   |
| Chief Executive Officer   |   |
| Date: April 8, 2005       |   |
|                      |   |
|                      |   |
| /s/ H. James Serrone      |   |   |
| H. James Serrone          |   |
| Chief Financial Officer   |   |
| Date:  April 8, 2005      |   |
|                           |        |  |  |

 

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